Published in Print: January 16, 2013, as Is Education Facing a 'Tech Bubble'?

Flood of Investment, Products Stirs Fears of Education 'Tech Bubble'

Karim Kai Ani, who founded the educational technology startup Mathalicious, takes notes while working on a project that uses toppings and prices of pizza to explain the fundamentals of linear functions to students.

—Stephen Voss for Education Week

Rush of investment, products mirrors 1990s, some warn

Educational technology companies and entrepreneurs may face the risk of a "tech bubble," similar to the massive boom-and-bust that rocked the technology market in the late 1990s, according to market analysts and a recently released paper.

A relatively new focus on K-12 educational technology as an investment vehicle, a surge of investors looking to cash in on the latest innovations, and fewer barriers to developing an ed-tech business have merged in ways that have some market observers wary of what's ahead.

The flurry of activity is prompting comparisons to the dot-com crash of the late 1990s, which brought the failure of many technology-related businesses that had drawn huge sums of money from investors.

Analysts say it is vital for today's money to flow to smart companies and ideas that can have a significant impact on improving schools—otherwise, the prospect of an ed-tech bubble bursting will loom larger, leaving schools with fewer high-quality products to choose from.

Frank Catalano, a principal consultant and analyst at Intrinsic Strategy, a Seattle-based consulting firm that specializes in educational technology, said he's pleased to see more startup activity in the K-12 arena, but has concerns about how the market is evolving.

"I worry the pendulum has swung too far," said Mr. Catalano, who addressed the issue in a paper last month for the MIT Enterprise Forum of the Northwest, based in Mountlake Terrace, Wash. The organization is a chapter of the MIT Enterprise Forum, a global nonprofit organization that seeks to support educational technology entrepreneurs, and is affiliated with the Massachusetts Institute of Technology.

"People say this is different [from the dot-com boom]," Mr. Catalano said, "but it's not that different."

Mathalicious employees, from left, Chris Lusto, Matt Lane, founder Karim Kai Ani, and Kate Nowak, talk about a new lesson involving slices of Domino's Pizza during a brainstorming session at the company's headquarters in Charlottesville, Va., last week.

—Stephen Voss for Education Week

In "Obstacles and Opportunities for Entrepreneurs in Education," the paper Mr. Catalano co-wrote with Shirley Lunde of Seattle-based Bader Martin, an accounting and business-advising company, the authors argue that interest in digital learning among entrepreneurs and investors may be rising for the wrong reasons.

Though ed-tech entrepreneurs seem to be more concerned with improving education than simply making a quick profit, money may be pouring into the marketplace based on exaggerated assessments of the growth of digital learning, the paper says.

Buzzing With Activity

The activity around investment in educational technology has certainly increased, said Karen Billings, the vice president of the education division for the Washington-based Software & Information Industry Association.

Industry competitions such as Startup Weekend EDU are proliferating and more-established ed-tech organizations, most notably the Washington-based International Society for Technology in Education, or ISTE, are focusing on entrepreneurs with special events at major conferences, she said.

Meanwhile, the number of incubator programs designed to nurture ed-tech startups has multiplied, as the number of companies seeking support from such programs over the past few years has spiked. In 2012, for example, the SIIA had 67 applicants to its Innovation Incubator program, compared with 15 in 2008, Ms. Billings said.

Money to finance ed-tech ventures is coming from sources like the social-financing website Kickstarter, large foundations, "angel investors" pitching in their own money, and venture capital funds, all of which have increased their presence in K-12 startups.

In 2005, just $13 million in venture and growth capital was invested in the K-12 market, a major drop-off from the years of the dot-com bubble. In 2011, venture capitalists put $389 million into K-12-focused companies, which dropped slightly to $305 million in 2012, according to GSV Advisors, a Chicago-based education investment bank that tracks the K-12 market.

Former math teacher Karim Kai Ani is one entrepreneur who may benefit from the trend.

Mr. Ani spent two years trying without much success to lure investors to his online education company, Mathalicious, designed to create Web-based interactive math lessons that relate the subject to the real world. He worked out of his mother's house and sold his photography equipment to finance most of the venture. But in recent months, after Mathalicious was highlighted by SIIA's Innovation Incubator contest, investors suddenly began peppering his inbox with offers of funding. Mr. Ani is evaluating those offers. He finds himself in a sector that is seen as hip for investors, as financiers search for the next great ed-tech startup.

Capital vs. Talent

But some investors may be rushing toward educational technology opportunities without a worthwhile place for their money, said Josh Cohen, the managing partner and co-founder of City Light Capital, a venture-capital firm based in New York City. He said he sees more "capital than talent" in the K-12 marketplace at this point.

Mr. Cohen said he's not looking at first-time entrepreneurs, and he only wants companies that can grow in big ways.

"We're not going to look at anything where it affects hundreds of people," he said. "We want thousands or millions."

Mr. Catalano of Intrinsic Strategy said not all investors are as savvy about the K-12 market, and that sets up the possibility of lots of money flowing to unstable companies or those without a strong business model.

"The impact of the investor who basically hasn't looked too deeply into this is that it tends to prop up products that are 'me too,' when there are already better solutions in the marketplace," Mr. Catalano said.

It is significantly cheaper to launch an ed-tech business in today's market than it was during the dot-com boom. The lower cost of overhead, including hardware and Web services, means that with a few people, adequate technology, and a virtual office, entrepreneurs' projects can grow quickly.

Some statistics reflect that new reality: The actual number of investments (not the dollar amount) that venture capitalists made in new and growing K-12 companies went from 48 in 2011 to 82 in 2012, despite the fact that the amount of money invested dropped slightly during that same time, according to GSV Advisors.

The higher number of transactions, paired with a slight drop in the value of the investments, reflects the low cost of starting such businesses and the need for fewer seed dollars.

That's why Deborah Quazzo, a managing partner for GSV Advisors, said this era is nothing like the dot-com boom. "There's much more efficient use of capital than we saw a decade ago," she said.

Also, said Jennifer Carolan, a partner for the Oakland, Calif.-based NewSchools Venture Fund, a nonprofit venture-philanthropy fund, though there may be more ed-tech startups, technology has not saturated schools. "The tools teachers are using in the classroom are not up to par with what they're using in their consumer life," she said.

To complicate matters, many of the startups may begin with a great ed-tech idea, but often don't have a sustainable business model, said Marguerite Roza, a research associate professor of education finance policy at Georgetown University, in Washington.

"Freemium" business models, in which companies offer free products or services with a plan to charge for them later on, haven't yet proved successful in the K-12 arena, she said. Others are relying on donor or investor funding with no long-term model for making profit.

Though Ms. Roza noted that there's $600 billion a year in public education funding, she said school districts aren't going to pay for ed-tech products unless they replace existing functions—such as allowing districts to hire fewer teachers.

I want to grab all these ed-tech people and shake them and say they need to think about how to solve financial problems for districts," she said. "They can't be an add-on."

'My Biggest Fear'

The danger for education officials in a bursting ed-tech bubble is that schools and districts could be left with empty investments in new technology.

"This would leave educators and administrators with a product they can't use, with data trapped inside it, and an increasing amount of cost to replace it," said Mr. Catalano.

Take Junyo, for example, a Menlo Park, Calif.-based company launched in 2011 to develop systems that analyze student data and help teachers improve learning. Junyo launched a blended learning platform for elementary schools, including those run by Rocketship Education, a San Jose, Calif.-based charter school management company. But in 2012, Junyo announced it would change course. Steve Schoettler, the founder and chief executive officer, said the company will no longer sell directly to schools, leaving Rocketship without the tools it hoped to use.

"It was definitely a challenge for us because they were hosting some of our programs and data," said Preston Smith, the president of Rocketship.

Rocketship didn't necessarily lose money on the deal, however, but Mr. Smith said the charter school organization will ultimately get less for its money in terms of data analysis than planned.

Some analysts worry that too many failures among ed-tech companies could scare off school districts that finally seem willing to take a chance on new innovations, said Adam J. Newman, a managing partner for Education Growth Advisers, an education business-advisory company in Stamford, Conn.

"My biggest fear is that if there is a significant 'clearing of the herd,' folks will use it as a reason not to do things and not to experiment," he said.

Mr. Schoettler, who has been involved with starting several other technology businesses, said the type of shift Junyo made is common in the startup field, but "the process of innovation is something school districts are not familiar with." School districts are just starting to be more open to working with new companies and products, and he's concerned that talk of an ed-tech bubble will make everyone wary. "If it scares away entrepreneurs and investors, it's bad for the industry," he said.

And Ms. Quazzo of GSV Advisors said the circumstances are different from those in the 1990s. In particular, she said, Race to the Top and other federal programs are encouraging districts to seek out technology-based ways to improve education. And the adoption of the Common Core State Standards is giving some startups the opportunity to grow faster and more naturally.

Mr. Ani of Mathalicious said it would have been cumbersome to adapt his math lessons to individual state standards, but the common core has allowed him to create interactive curricula for all states.

Mr. Pines of the Education Industry Association said a rush to invest in the ed-tech marketplace is no doubt under way, and that may raise some concerns. But he was quick to note that's part of the typical progression of new industries.

"All businesses go through a cycle of wild effervescence, and this excitement will ultimately reach a peak and plateau, and we'll probably have a downward trend as maturing takes place," he said. "We're experiencing that cycle with the current ed-tech trend."

Assistant Editor Sean Cavanagh contributed to this article.

Coverage of the education industry and K-12 innovation is supported in part by a grant from the Bill & Melinda Gates Foundation.

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